<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of report (Date of Earliest Event Reported): June 2, 1999
QUEST DIAGNOSTICS INCORPORATED
(Exact name of registrant as specified in charter)
<TABLE>
<S> <C> <C>
DELAWARE 1-12215 16-1387862
(State or other jurisdiction (Commission File Number) (I.R.S. Employer
of incorporation) Identification
No.)
ONE MALCOLM AVENUE, TETERBORO, NEW JERSEY 07608
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's telephone number, including area code: (201) 393-5000
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Exhibit Index appears on page 2.
<PAGE>
ITEM 5. OTHER EVENTS.
As previously disclosed in Quest Diagnostics Incorporated's ("Quest
Diagnostics") current report on Form 8-K dated February 17, 1999, on February 9,
1999, Quest Diagnostics signed a definitive agreement with SmithKline Beecham
plc ("SmithKline Beecham") to purchase SmithKline Beecham's clinical laboratory
testing business ("SBCL") for approximately $1.3 billion in cash and stock (the
"SBCL Acquisition"). The purchase price will be paid through the issuance of
approximately 12.6 million shares of common stock of Quest Diagnostics and the
payment of $1.025 billion of cash. Quest Diagnostics expects to close the
transaction by July 1999.
Attached and incorporated by reference herein as Exhibits 99.1, 99.2 and
99.3, respectively, are certain financial information for SBCL, management's
discussion and analysis of financial condition and results of operations related
thereto and unaudited pro forma combined financial information for the combined
entity giving effect to the SBCL Acquisition.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
(c) Exhibits.
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
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<C> <S>
99.1 The unaudited combined balance sheets of SmithKline Beecham Clinical Laboratories, Inc. and certain
related affiliates as of March 25, 1999 and December 31, 1998 and the related combined statements of
operations, cash flows and changes in parent's equity for the three months ended March 25, 1999 and
March 26, 1998.
99.2 Management's discussion and analysis of financial condition and results of operation for SmithKline
Beecham Clinical Laboratories, Inc. and certain related affiliates.
99.3 The Quest Diagnostics unaudited pro forma combined balance sheet at March 31, 1999 and statements of
operations for the three months ended March 31, 1999, the twelve months ended March 31, 1999 and the
year ended December 31, 1998.
</TABLE>
2
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
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<S> <C> <C>
June 4, 1999
QUEST DIAGNOSTICS INCORPORATED
By: /s/ ROBERT A. HAGEMANN
-----------------------------------------
Name: Robert A. Hagemann
Vice President and Chief Financial
Officer
</TABLE>
3
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EXHIBIT 99.1
SMITHKLINE BEECHAM CLINICAL LABORATORIES, INC.
AND CERTAIN RELATED AFFILIATES
COMBINED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 25, DECEMBER 31,
1999 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash............................................................................... $ 2,178 $ --
Accounts receivable (net of allowances of $79,610 and $86,396, respectively)....... 394,199 356,102
Inventories........................................................................ 18,234 17,934
Prepaid expenses and other current assets.......................................... 10,319 9,975
------------ ------------
Total current assets........................................................... 424,930 384,011
Goodwill and other intangibles, net.................................................. 499,640 503,879
Property, plant and equipment, net................................................... 205,272 215,519
Other assets......................................................................... 14,478 35,862
------------ ------------
Total assets................................................................... $ 1,144,320 $1,139,271
------------ ------------
------------ ------------
LIABILITIES AND PARENT'S EQUITY
Current liabilities:
Accounts payable................................................................... $ 47,402 $ 39,152
Current portion of long-term debt.................................................. 2,224 2,160
Accrued compensation and benefits.................................................. 24,001 37,657
Estimated out-of-network laboratory claims......................................... 24,358 --
Other current liabilities.......................................................... 60,883 45,644
------------ ------------
Total current liabilities...................................................... 158,868 124,613
Long-term debt....................................................................... 32,306 32,902
Deferred income...................................................................... 750 --
Commitments and contingent liabilities
Parent's equity...................................................................... 952,396 981,756
------------ ------------
Total liabilities and Parent's equity.......................................... $ 1,144,320 $1,139,271
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of the combined financial
statements.
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SMITHKLINE BEECHAM CLINICAL LABORATORIES, INC.
AND CERTAIN RELATED AFFILIATES
COMBINED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------
<S> <C> <C>
MARCH 25, MARCH 26,
1999 1998
---------- ----------
Net revenues.............................................................................. $ 413,332 $ 346,513
Costs and expenses:
Cost of services........................................................................ 295,293 235,351
Provision for bad debts................................................................. 35,606 31,558
Selling, general and administrative..................................................... 66,034 65,053
Interest expense, net................................................................... 11,309 11,258
Amortization of goodwill and intangibles................................................ 7,442 7,163
Other income, net....................................................................... (9,203) (11,380)
---------- ----------
Total costs and expenses.................................................................. 406,481 339,003
---------- ----------
Income before taxes....................................................................... 6,851 7,510
Income tax expense........................................................................ 4,840 5,104
---------- ----------
Net income................................................................................ $ 2,011 $ 2,406
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of the combined financial
statements.
2
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SMITHKLINE BEECHAM CLINICAL LABORATORIES, INC.
AND CERTAIN RELATED AFFILIATES
COMBINED STATEMENTS OF CHANGES IN PARENT'S EQUITY
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
MARCH, 25 MARCH 26,
1999 1998
---------- ----------
<S> <C> <C>
Balance, beginning of year................................................................ $ 981,756 $ 992,949
Net income................................................................................ 2,011 2,406
Net transfers to Parent................................................................... (31,371) (17,616)
---------- ----------
Balance, end of period.................................................................... $ 952,396 $ 977,739
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of the combined financial
statements.
3
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SMITHKLINE BEECHAM CLINICAL LABORATORIES, INC.
AND CERTAIN RELATED AFFILIATES
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------
MARCH 25, MARCH 26,
1999 1998
---------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................................ $ 2,011 $ 2,406
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization......................................................... 15,666 16,004
Gain on sale of assets................................................................ (9,802) (4,280)
Provisions for bad debts.............................................................. 35,606 31,558
Equity in undistributed earnings of affiliates........................................ (403) (230)
Changes in assets and liabilities:
Increase in accounts receivable..................................................... (73,703) (40,601)
Increase in inventories............................................................. (300) (1,120)
Increase in prepaid expenses and other current assets............................... (344) (252)
Increase in other assets............................................................ (23) (99)
Increase in estimated out-of-network laboratory claims.............................. 24,358 --
Increase in accounts payable, accrued compensation and benefits and other current
liabilities....................................................................... 9,633 13,153
---------- ----------
Net cash provided by operating activities................................................. 2,699 16,539
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures...................................................................... (3,226) (5,516)
Proceeds from sale of assets.............................................................. 2,014 117
Expenditures for other intangible assets.................................................. (216) --
---------- ----------
Net cash used in investing activities..................................................... (1,428) (5,399)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net transfers from (to) Parent............................................................ 1,439 (17,616)
Repayment of long-term debt............................................................... (532) (525)
---------- ----------
Net cash provided by (used in) financing activities....................................... 907 (18,141)
---------- ----------
Increase (decrease) in cash............................................................... 2,178 (7,001)
Cash, beginning of year................................................................... -- 8,919
---------- ----------
Cash, end of period....................................................................... $ 2,178 $ 1,918
---------- ----------
---------- ----------
Supplemental cash flow information:
Cash paid for:
Interest.............................................................................. $ 554 $ 603
Non cash investing and financing activities:
Stock received in exchange for assets................................................... $ 11,000 $ 2,800
Deferred income from sale of assets..................................................... $ 950 $ --
Investment in stock transferred to Parent............................................... $ 32,810 $ --
</TABLE>
The accompanying notes are an integral part of the combined financial
statements.
4
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SMITHKLINE BEECHAM CLINICAL LABORATORIES, INC.
AND CERTAIN RELATED AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
SmithKline Beecham Clinical Laboratories, Inc. is a subsidiary of SmithKline
Beecham Corporation ("SmithKline Beecham Corp"), itself an indirect subsidiary
of SmithKline Beecham plc ("SmithKline Beecham plc" or the "Parent"), a public
limited company incorporated in 1989 under the laws of England and Wales. The
other entities combined in these financial statements are also indirectly owned
subsidiaries of SmithKline Beecham plc.
The combined financial statements of SmithKline Beecham Clinical
Laboratories, Inc., and certain related affiliates ("the Company"), include the
accounts of the following:
- SBCL Inc. (US)
- SmithKline Beecham Clinical Laboratories Inc. (US)
- The clinical laboratory operations of Fournex SA (Belgium)
- The clinical laboratory operations of SmithKline Beecham Laboratoires
Pharmaceutiques SA (France)
- The clinical laboratory operations of SmithKline Beecham Capital BV
(Netherlands)
- The clinical laboratory operations of SmithKline Beecham plc (UK)
The combined financial statements reflect the assets and liabilities,
results of operations and cash flows of the Company as if the Company had
existed and operated as a separate business.
In the opinion of management, the accompanying interim combined financial
statements contain all adjustments necessary to present fairly the financial
position of the Company as of March 25, 1999 and the results of operations and
cash flows for the three months ended March 25, 1999 and March 26, 1998. All
adjustments, except for an accrual for costs to provide free counseling and
blood tests to certain patients (see Note 3), are normal and recurring in
nature. The interim combined financial statements are unaudited and are subject
to year-end adjustment. The results of operations for the interim period are not
necessarily indicative of the results expected for the full year. These interim
combined financial statements should be read in conjunction with the Company's
audited combined financial statements as of December 31, 1998, and for the year
then ended.
PRINCIPLES OF COMBINATION
All significant intercompany accounts and transactions within the Company
have been eliminated as part of the combination. Investments in companies which
are 20-50 percent owned by the Company are accounted for using the equity method
of accounting. All other investments are accounted for using the cost method.
FISCAL PERIOD
The Company operates on a calendar year basis for annual reporting purposes.
For interim reporting purposes, the Company operates on a 13 week fiscal period
that ends on the last Thursday of the calendar quarter.
5
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SMITHKLINE BEECHAM CLINICAL LABORATORIES, INC.
AND CERTAIN RELATED AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
(UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ESTIMATED OUT-OF-NETWORK LABORATORY CLAIMS
The Company is a party to two full risk capitated agreements with managed
care organizations (MCOs) to provide laboratory services to certain MCO members.
These services are provided by the Company and by independent laboratories under
terms of the agreements with the MCOs. Services under these arrangements are
reimbursed by the MCOs at contractually established rates. Expenses incurred
under these contracts are included in cost of services in the Company's combined
statement of operations. The estimated liability for out-of-network laboratory
claims outstanding is based upon an estimate of incurred but not reported
claims. Methods used to determine the estimates are continually revised and any
resulting adjustments are included in current operating results. The Company
does not purchase reinsurance, as it retains the underwriting risk for all
coverages under the contract.
(2) OTHER INCOME, NET
Other income, net, is comprised primarily of gain on the sale of assets of
$9,802 for the three months ended March 25, 1999, and gain on the sale of assets
of $4,280 and income from a customer contract related settlement of $7,700 for
the three months ended March 26, 1998.
(3) CONTINGENT LIABILITIES
The Company is involved in various legal and administrative proceedings
considered normal to its business, including suits claiming damages arising from
the Company's services. The Company is also a party to legal proceedings with
regard to environmental matters.
In 1996, the Company and the U.S. government and certain states reached a
settlement with respect to the government's civil and administrative claims
arising from an investigation by the Office of the Inspector General of the U.S.
Department of Health and Human Services into the Company's billing and marketing
practices. In connection therewith, certain affiliates of the Company paid the
government $325 million which had been reserved in prior years.
The Company is also responding to claims and lawsuits from non-governmental
parties, including private insurers, self-funded employer plans and patients,
concerning similar practices as they may relate to amounts paid by those
parties. The lawsuits include ten purported class actions filed in various
jurisdictions in the United States and one non-class action complaint by a
number of insurance companies that seek damages allegedly arising from payments
they made for clinical laboratory testing services. Nine of the purported class
actions have been consolidated into one complaint which has been consolidated
with the insurers' suit, for pretrial proceedings, in the U.S. District Court
for the District of Connecticut. The other purported class action remains
pending in state court in Illinois. Similar claims by several other individual
third party payers have been settled. SmithKline Beecham plc has agreed to
indemnify the Company for the after-tax expense of any similar such settlements
entered into after December 31, 1998.
On March 22, 1999, the Company learned that an employee at a patient service
center in Palo Alto, California had at times reused certain needles when drawing
blood from patients. The phlebotomist, who was immediately suspended and
thereafter terminated, drew blood from approximately 3,600 patients while
working at that center from June 1997 until her suspension. She had previously
worked at a number of other Company and non-Company sites in the area. The
Company
6
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SMITHKLINE BEECHAM CLINICAL LABORATORIES, INC.
AND CERTAIN RELATED AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
(UNAUDITED)
(3) CONTINGENT LIABILITIES (CONTINUED)
has notified the 3,600 patients whose blood may have been drawn by this
phlebotomist subsequent to May 31, 1997 and has offered free counseling and
follow-up blood tests to determine whether those patients have been exposed to
hepatitis B, hepatitis C or HIV. The Company is cooperating with local, state
and federal health agencies to address public health issues arising from the
employee's breach of standard medical practices. SBCL has announced that it is
offering testing to 11,687 additional patients who had blood drawn at facilities
where the phlebotomist worked during times from 1994 to 1996, including patients
whose blood was drawn at sites where multiple phlebotomists worked (11,076
patients). SBCL is offering such testing even though many of those patients did
not have their blood drawn by this phlebotomist and the state health authorities
do not recommend testing for those patients. A number of civil actions,
including some purporting to be class actions, have been filed against the
Company in federal and state courts in California on behalf of patients who may
have been affected by the phlebotomist's reuse of needles or other allegedly
improper practices. An initial provision for the estimated cost of the free
counseling and follow-up blood tests for the affected patients has been included
in cost of services in the Company's combined statement of operations for the
three months ended March 25, 1999, but at this stage the total costs associated
with this matter are not yet determinable. SmithKline Beecham has agreed to
amend the stock and asset purchase agreement with Quest Diagnostics Incorporated
("Quest Diagnostics") (see Note 5) to provide that SmithKline Beecham plc will
indemnify Quest Diagnostics and the Company for the out-of-pocket costs of the
counseling and testing, for liabilities arising out of the civil actions and for
other losses arising out of the conduct of this employee, other than
consequential damages.
Although the outcome of claims, legal proceedings and other matters in which
the Company is involved cannot be predicted with any certainty, the Company does
not expect that its ultimate liability for such matters, after taking into
account provisions, tax benefits and insurance, to have a material adverse
effect on its financial condition, results of operations or cash flows.
(4) COMMITMENTS
The Company has financed two facilities with capital leases. In 2000, the
capital leases on these facilities will expire, at which point the Company has
three options: extend the leases for three years, at which point the Company is
obligated to purchase the facilities, purchase the facilities or find a third
party to purchase the facilities. If the last option is chosen, the Company is
liable for any difference between the residual value and the fair market value
if the residual value exceeds the fair value. The future minimum lease payments
due under these leases is $28,138 as of March 25, 1999 (see Note 5).
SmithKline Beecham Clinical Laboratories, Inc. is a guarantor of debt
related to the aforementioned capital leases. At December 31, 1998 total
guaranteed debt outstanding approximated the Company's payables to the lessor.
(5) SALE OF THE COMPANY
On February 9, 1999, SmithKline Beecham plc entered into an agreement to
sell the Company to Quest Diagnostics in exchange for approximately $1 billion
of cash and 12.6 million shares of Quest Diagnostics' common stock, which will
approximate 29.5% of Quest Diagnostics' outstanding shares at closing. As part
of the purchase agreement, various compensation plans will be altered. Also, as
a result of the transaction with Quest Diagnostics, the future capital lease
commitments may be accelerated due to change in control provisions of the lease
agreements.
7
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EXHIBIT 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In December 1997, SBCL entered into an agreement with a third party pursuant
to which SBCL licensed the intellectual property associated with its SBCL SCAN
connectivity technology, which enables electronic communication between SBCL and
its larger physician customers. Under that agreement SBCL outsourced its
physician connectivity services for these customers and sold its physician
connectivity hardware and related contract rights in stages over 1997 and 1998.
SBCL's operating results included license and asset sales income of $14.9
million in 1998 and $6.1 million in 1997 from this transaction.
In December 1998, SBCL reached an agreement to sell its physician
office-based teleprinter assets and network to the same third party. This
transaction was completed in January 1999. The financial impact of this
transaction was reported in the first quarter 1999 results.
During the third quarter of 1998, SBCL introduced SELECTEST, a new, more
specific process and test requisition form for ordering diagnostic laboratory
tests that streamlines test ordering and facilitates compliance with changes in
the regulatory environment. The new test requisition form offers the test panels
recommended by the American Medical Association. Although SBCL has not
experienced a significant impact on overall test volumes in 1998, it did
experience a decline in the ordering of certain tests. SBCL believes the AMA
approved panels may continue to result in fewer tests ordered per requisition.
During 1998, SBCL entered into risk sharing agreements with certain managed
care organizations to provide clinical laboratory services. Under the terms of
these agreements, SBCL performs laboratory testing for certain customers of
these managed care organizations at normal reimbursement rates. In addition,
during the first quarter of 1999, SBCL assumed responsibility for managing the
laboratory testing costs for which these managed care organizations are at risk,
including the cost of testing performed within the SBCL laboratory network and
the cost of testing performed by third parties on behalf of SBCL. During the
three months ended March 25, 1999, the cost of testing performed by third
parties related to the at risk contracts was $24.4 million. Subject to the
satisfaction of certain conditions detailed in the contracts, savings in excess
of a specific amount will be shared by the parties.
On March 22, 1999, SBCL learned that an SBCL employee at a patient service
center in Palo Alto, California had at times reused certain needles when drawing
blood from patients. The phlebotomist was immediately suspended and then
terminated. SBCL is cooperating with local, state and federal health agencies to
address public health issues arising from the employee's breach of standard
medical practices. SBCL has announced that it is offering testing to 11,687
additional patients who had blood drawn at facilities where the phlebotomist
worked during times from 1994 to 1996, including patients whose blood was drawn
at sites where multiple phlebotomists worked (11,076 patients). SBCL is offering
such testing even though many of those patients did not have their blood drawn
by this phlebotomist and the state health authorities do not recommend testing
for those patients. A number of civil actions, including some purporting to be
class actions, have been filed against SBCL in federal and state courts in
California on behalf of patients who may have been affected by the
phlebotomist's reuse of needles or other alleged improper practices. SmithKline
Beecham has agreed to amend the stock and asset purchase agreement to indemnify
Quest Diagnostics against out-of-pocket costs related to counseling and testing,
liabilities associated with the civil actions and other losses arising out of
this matter.
1
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THREE MONTHS ENDED MARCH 25, 1999 COMPARED WITH THREE MONTHS ENDED MARCH 26,
1998. SBCL follows the financial reporting calendar of its parent, SmithKline
Beecham plc. Under this calendar, the first quarter ends on the fourth Thursday
of March, which typically results in the first quarter being a short quarter, in
terms of total business days. Conversely, the fourth quarter is normally a long
quarter. In 1999, there are 59 business days in the first quarter. In 1998,
there were 60 business days in the first quarter.
Net earnings decreased for the first quarter of 1999 compared to the first
quarter of 1998 principally as a result of a decrease in other income, net.
Excluding the impact of the new managed care contracts, there was a small
increase in cost of services and provision for bad debts as a percent of net
revenues, but this was more than offset by a reduction in selling, general and
administrative expenses. This partially offset the decrease in other income,
net.
NET REVENUES
Net revenues increased by $66.8 million (19.3%) for the first quarter of
1999 compared to the first quarter of 1998. The growth included $31.0 million
associated with the at-risk portion of the new managed care organization
contracts and higher sales of $13.3 million from hospital management contracts.
Clinical testing volumes increased by 1.8% (3.5% on a per day basis) and the
average price per test for clinical testing increased by 7.9% for the first
quarter of 1999 compared to the first quarter of 1998. Factors contributing to
the increase in the average price per test were the introduction of the
SelecTest requisition and lower than normal average prices in the first quarter
of 1998.
COSTS AND EXPENSES
Total costs and expenses increased $67.5 million for the first quarter of
1999 compared to the first quarter of 1998. The increase was primarily
attributable to a $59.9 million increase in the cost of services, a $4.0 million
increase in the provision for bad debt, a $1.0 million increase in selling,
general, and administrative expenses, and a $2.2 million decrease in other
income, net.
Costs of services increased by $59.9 million for the first quarter of 1999
compared to the first quarter of 1998 of which $24.4 million was attributable to
the estimated cost of testing performed outside the SBCL laboratory network
related to the at-risk portion of the new managed care organization contracts.
Cost of services as a percentage of net revenues increased to 71.4% for the
first quarter of 1999 from 67.9% for the first quarter of 1998. This increase as
a percentage of net revenues was attributable to the at-risk portion of the new
managed care organization contracts, expenses related to the hospital management
network and clinical trials service and distribution capabilities. For all other
operations, cost of services as a percentage of net revenues experienced a
slight reduction.
Selling, general, and administrative expenses increased $1.0 million for the
first quarter of 1999 compared to the first quarter of 1998, due primarily to an
increase in billing expenses. As a percentage of net revenues, excluding the
sales impact of the new managed care organization contracts, selling, general
and administrative expenses decreased to 17.3% for the first quarter of 1999
from 18.8% for the first quarter of 1998.
The provision for bad debts as a percentage net revenues, excluding the
sales impact of the new managed care organization contracts, increased to 9.3%
for the first quarter of 1999 from 9.1% for the first quarter of 1998.
Interest expense and amortization of goodwill and intangibles increased by
$0.1 million and $0.3 million, respectively, for the first quarter of 1999
compared to the first quarter of 1998. The increase in interest expense is
attributable to a marginal increase in intercompany loans from SmithKline
Beecham. Intercompany loan activity was included as a component of parent's
equity. The increase in
2
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amortization of goodwill and intangibles was due to the amortization of software
capitalized during 1998.
Other income, net, declined $2.2 million for the first quarter of 1999
compared to the first quarter of 1998 due to a customer contract related
settlement in the first quarter of 1998, offset partially by a larger gain on
sale of assets in the first quarter of 1999 compared to the first quarter of
1998.
SBCL's effective tax rate was significantly impacted by goodwill
amortization, most of which was not deductible for tax purposes. Income tax
expense was $4.8 million for the first quarter of 1999 compared to $5.1 million
for the first quarter of 1998. The decrease was attributable to the decrease in
income before taxes.
ADJUSTED EBITDA
Adjusted EBITDA represents income (loss) before income taxes plus net
interest expense, depreciation and amortization and special charges. Adjusted
EBITDA is presented and discussed because management believes it is a useful
adjunct to net income and other measurements under generally accepted accounting
principles since it is a meaningful measure of a leveraged company's performance
and ability to meet its future debt service requirements, fund capital
expenditures and meet working capital requirements. Adjusted EBITDA is not a
measure of financial performance under accounting principles generally accepted
in the United States and should not be considered as an alternative to (1) net
income, or any other measure of performance under accounting principles general
accepted in the United States, as a measure of performance or (2) cash flows
from operating, investing or financing activities as an indicator of cash flows
or as a measure of liquidity. Adjusted EBITDA for the first quarter of 1999
excluded the gain on sale of assets of $9.8 million, and for the first quarter
of 1998 excluded the gain on sale of assets of $4.3 million and income from a
customer contract related settlement of $7.7 million.
Adjusted EBITDA was $24.0 million for the first quarter of 1999 and $22.8
million for the first quarter of 1998. Adjusted EBITDA, as a percentage of net
revenues adjusted for the sales impact of the new managed care organization
contracts, decreased to 6.3% for the first quarter of 1999 from 6.6% for the
first quarter of 1998. The decline was primarily due to the establishment of a
provision for the estimated costs of patient testing and counseling related to
the improper conduct of an employee in northern California. See note 3 to SBCL's
unaudited combined financial statements at and for the three months ended March
25, 1999.
LIQUIDITY AND CAPITAL RESOURCES
Historically SBCL financed its operations and growth with cash flow from its
own operations and borrowings from SmithKline Beecham. Net cash provided by
operating activities decreased by $13.8 million for the first quarter of 1999
compared to the first quarter of 1998. The decrease was primarily due to a
decrease in net income before non-cash items, and a larger increase in accounts
receivable, due to the sales increase in the first quarter of 1999 compared to
the first quarter of 1998, offset partially by an increase in estimated
out-of-network laboratory claims incurred as a result of the new managed care
organization contracts.
The number of days sales outstanding of accounts receivable was 85.8 days at
the end of March 1999 compared to 87.9 days at the end of March 1998. This
improvement in days sales outstanding was primarily due to improvements in
collections from third party payers.
Capital expenditures were $3.2 million and $5.5 million for the three months
ended March 25, 1999 and March 26, 1998, respectively, and were primarily for
information technology and laboratory equipment. Capital expenditures for 1999
are anticipated to be approximately $35 million to $40 million. Significant
investments are expected to include the purchase of imaging technology. Net
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cash used in investing activities decreased $4.0 million for the first quarter
of 1999 compared to the first quarter of 1998. The decrease is attributable to a
decrease in capital spending and the receipt of $2.0 million in cash proceeds
from the sale of assets in 1999.
Net cash provided by financing activities was $0.9 million in the first
quarter of 1999. Net cash used in financing activities was $18.1 million in the
first quarter of 1998. Net cash transferred consists of cash managed centrally
by SmithKline Beecham and the payment of intercompany charges and debts.
YEAR 2000 READINESS DISCLOSURE
The Year 2000 issue relates to the ability of computer systems and programs
to properly recognize dates beginning January 1, 2000 and beyond. Also, the Year
2000 issue affects systems and equipment, such as security systems and
elevators, that contain imbedded hardware or software that may be similarly date
sensitive. As a result, business and governmental entities are at risk for
possible miscalculations or system failures resulting from Year 2000 problems
that may disrupt their operations.
SmithKline Beecham established a Year 2000 project office in early 1996,
which developed a Year 2000 methodology in 1997. In 1996, SBCL identified a
dedicated project manager responsible for ensuring that SBCL followed this
methodology which is comprised of the following four phases:
1. Assessment and Strategy--Determine the scale of the problem and
solutions for its resolution;
2. Detailed Analysis and Planning--Identify Year 2000 code and data
changes and plan their implementation;
3. Implementation--Change and test Year 2000 code/data, hardware and
embedded systems; and
4. Ongoing Compliance Management--Prevent re-introduction of Year 2000
problems.
SBCL expects that its business critical systems will be Year 2000 compliant
by mid-1999. SBCL follows a rigorous verification program to validate that all
Year 2000 remediation and testing work has been accomplished consistent with the
standards of its Year 2000 methodology. SBCL's progress in completing its Year
2000 implementation plan is reported regularly to SmithKline Beecham's senior
executives, audit committee and board of directors.
Due to the general uncertainty inherent in the Year 2000 problem, resulting
in part from the uncertainty of the Year 2000 readiness of third party vendors
and payers, SBCL is unable to determine at this time whether the consequences of
potential Year 2000 business disruptions will have a material impact on SBCL's
results of operations, liquidity or financial condition. The most reasonably
likely worst case consequences of SBCL or key vendors or payers not being ready
by January 1, 2000, include, among other things, temporary business unit
closures, delays in laboratory testing or delivery of laboratory testing
results, inventory shortages and delays in collecting accounts receivable. While
SBCL believes that its Year 2000 readiness program significantly reduces the
potential adverse effect of any such disruptions, SBCL cannot guarantee that the
Year 2000 problem will not result in material business disruptions. Specific
factors that give rise to this uncertainty include the possible loss of
technical resources, failure to identify all susceptible systems, non-compliance
by third parties whose systems impact SBCL, and other similar uncertainties.
SBCL will also face the same issues described above for governmental repayment
as Quest Diagnostics.
SBCL recognizes that there are risks posed by non-compliant customers and
suppliers. SBCL could experience a business disruption if one or more of its
suppliers experience disruption or where the functioning of public
infrastructure breaks down. To mitigate risks, SBCL is launching a Year 2000
business continuity program under which Year 2000 contingency plans, millennium
rollover plans and
4
<PAGE>
business resumption plans for critical processes will be defined. For instance,
with nationally standardized test codes and systems, SBCL has the ability to
move laboratory specimens to alternate sites in the event that a local
laboratory experiences disruption.
SBCL's costs directly associated with Year 2000 compliance amounted to $8.1
million in 1998 and $2.5 million in 1997. It is expected that directly
attributable Year 2000 costs will not exceed $20.0 million through December 31,
2000. Total capital expenditure for Year 2000 compliance through 1998 was $1.3
million, and is expected to be $3.3 million in 1999. All costs related to Year
2000 activities and installation of new systems are being funded through
operating cash flows and deferral of other projects.
INFLATION
We believe that inflation generally does not have a material adverse effect
on our operations or financial condition because the majority of our contracts
are short term.
EXCHANGE RATE FLUCTUATIONS
We believe that currency exchange rate fluctuations do not have a material
impact on our financial condition because the amount of business exposed to
changes in exchange rates is immaterial to our overall financial performance.
5
<PAGE>
EXHIBIT 99.3
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
The following unaudited pro forma combined financial statements of Quest
Diagnostics have been prepared to illustrate the effects of the following
transactions:
- Quest Diagnostics' purchase of SBCL. In the stock and asset purchase
agreement, Quest Diagnostics agreed to issue to SmithKline Beecham
approximately 12.6 million shares of Quest Diagnostics common stock and
pay $1.025 billion in cash, which includes $20 million payable under the
non-competition agreement (the "SBCL acquisition").
- Quest Diagnostics will finance the cash purchase price and transaction
expenses associated with the SBCL acquisition, repay its existing bank
debt and repurchase in a tender offer its 10 3/4% senior subordinated
notes with cash on-hand, borrowings under the new credit facility and the
proceeds of a private placement of senior subordinated notes.
The unaudited pro forma combined balance sheet as of March 31, 1999 gives
effect to the SBCL acquisition and the anticipated borrowings under the new
credit facility and the new notes as if they had occurred on March 31, 1999. The
unaudited pro forma combined statements of operations assume the SBCL
acquisition, the anticipated borrowings under the new credit facility and the
new notes and the repurchase of the 10 3/4% notes were effected on the first day
of such period. The SBCL acquisition will be accounted for under the purchase
method. As such, the cost to acquire SmithKline Beecham's clinical laboratory
testing business will be allocated to the assets and liabilities acquired based
on estimated fair values at the completion of the SBCL acquisition. A
preliminary allocation of the acquisition cost has been made to the assets and
liabilities of SBCL in the unaudited pro forma combined financial statements
based on estimates. The final allocation may be different from the amounts
reflected in these pro forma financial statements. The estimated costs
associated with severance and other integration-related activities for 1999 and
2000, including the elimination of duplicate facilities and excess capacity,
operational realignment and related workforce reductions are included in the
unaudited pro forma combined balance sheet as of March 31, 1999. We estimate
that we will incur about $200 million of additional costs in subsequent years to
integrate Quest Diagnostics and SBCL. A significant portion of these costs are
expected to require cash outlays. These estimates are preliminary and will be
subject to revisions as integration plans are developed and finalized. The
unaudited pro forma combined statements of operations exclude the impact of
nonrecurring costs and benefits directly related to the SBCL acquisition and
anticipated borrowings under the new credit facility and the new notes including
the costs and benefits associated with the integration of Quest Diagnostics and
SBCL, the costs and fees related to the capital markets loan facility of the new
credit facility from which Quest Diagnostics does not expect to draw and the
costs and expenses related to Quest Diagnostics' tender offer of its existing
10 3/4% notes.
The pro forma adjustments, and the assumptions on which they are based, are
described in the accompanying notes to the unaudited pro forma combined
financial statements.
Assets and liabilities, for which the obligation is being retained by
SmithKline Beecham through an indemnity to Quest Diagnostics, have been
reflected in the historical financial statements of SBCL and related affiliates
as a component of parent's equity. The indemnified assets and liabilities, which
primarily relate to taxes and liabilities for billing and professional liability
claims of SBCL and related affiliates, are not reflected in the unaudited pro
forma combined balance sheet as assets and liabilities.
The unaudited pro forma combined financial statements are presented for
illustrative purposes only to aid you in your analysis of the financial aspects
of the SBCL acquisition. You should not rely on the unaudited pro forma combined
financial information as being indicative of the combined financial position or
results of operations that would have been realized had Quest Diagnostics and
SBCL been
1
<PAGE>
a single entity during the periods presented. In addition, the unaudited pro
forma combined financial information is not necessarily indicative of the future
results that the combined company will experience after the SBCL acquisition.
The unaudited pro forma combined financial statements and related notes should
be read in conjunction with the historical financial statements of Quest
Diagnostics and SBCL.
2
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
MARCH 31, 1999
(IN THOUSANDS)
<TABLE>
<CAPTION>
QUEST PRO FORMA
DIAGNOSTICS SBCL ADJUSTMENTS PRO FORMA
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS
Cash............................................ $ 154,197 $ 2,178 $ 1,363,371(a)
(41,982 (b) $
(23,231 (c) 10,000
(408,369 (d)
(2,178 (e)
(1,025,000 (f)
(8,986 (g)
Accounts receivable, net........................ 229,786 394,199 --(j) 623,985
Other current assets............................ 146,656 28,553 30,900 )(1 245,609
17,775 )(3
21,725(h)
------------ ------------ ------------- ------------
Total current assets.......................... 530,639 424,930 (75,975) 879,594
PROPERTY, PLANT AND EQUIPMENT, NET................ 241,295 205,272 (40,500 (2) 356,567
(49,500 (h)
INTANGIBLE ASSETS, NET............................ 489,784 499,640 357,585 )(4 1,347,009
OTHER ASSETS...................................... 56,481 14,478 39,263(b) 138,044
1,074(b)
(7,689 (d)
(1,114 (2)
15,998 )(3
19,553(h)
------------ ------------ ------------- ------------
TOTAL ASSETS...................................... $ 1,318,199 $ 1,144,320 $ 258,695 $ 2,721,214
------------ ------------ ------------- ------------
------------ ------------ ------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses........... $ 252,759 $ 156,644 $ (9,176 (c) $
(7,119 (d) 488,703
(3,037 (d)
53,986 )(2
(8,986 (g)
55,000(h)
(1,368 (i)
Revolving credit facility....................... -- -- 38,371(a) 38,371
Current portion of long-term debt............... 56,446 2,224 23,125(a) 25,795
(56,000 (d)
------------ ------------ ------------- ------------
Total current liabilities..................... 309,205 158,868 84,796 552,869
LONG-TERM DEBT.................................... 360,187 32,306 1,301,875(a) 1,349,118
(345,250 (d)
OTHER LIABILITIES................................. 71,520 750 -- 72,270
PREFERRED STOCK................................... 1,000 -- -- 1,000
COMMON STOCKHOLDERS' EQUITY....................... 576,287 952,396 (1,645 (b) 745,957
(14,055 (c)
(4,652 (d)
(2,178 (e)
(698,342 (4)
(63,222 (h)
1,368(i)
------------ ------------ ------------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........ $ 1,318,199 $ 1,144,320 $ 258,695 $ 2,721,214
------------ ------------ ------------- ------------
------------ ------------ ------------- ------------
</TABLE>
See the accompanying notes to the unaudited pro forma combined financial
statements.
3
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
QUEST PRO FORMA
DIAGNOSTICS SBCL ADJUSTMENTS PRO FORMA
----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
NET REVENUES............................................... $ 381,841 $ 413,332 $ $ 795,173
COSTS AND EXPENSES
Cost of services......................................... 226,995 295,293 (4,119)(k) 518,169
Selling, general and administrative...................... 127,013 101,640 (1,334)(k)
(843)(l)
740(m) 227,216
Interest expense, net.................................... 7,359 11,309 1,557(n)
10,657(o) 30,882
Amortization of intangible assets........................ 5,094 7,442 (1,209)(p) 11,327
Other, net............................................... 1,302 (9,203) (740)(m)
9,802(q) 1,161
----------- ---------- ----------- -----------
Total................................................ 367,763 406,481 14,511 788,755
----------- ---------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES.......................... 14,078 6,851 (14,511) 6,418
INCOME TAX EXPENSE (BENEFIT)............................... 6,645 4,840 (6,604)(r) 4,881
----------- ---------- ----------- -----------
NET INCOME (LOSS).......................................... $ 7,433 $ 2,011 $ (7,907) $ 1,537
----------- ---------- ----------- -----------
----------- ---------- ----------- -----------
BASIC NET INCOME PER COMMON SHARE(S)....................... $ 0.25 $ 0.04
----------- -----------
----------- -----------
DILUTED NET INCOME PER COMMON SHARE(S)..................... $ 0.24 $ 0.04
----------- -----------
----------- -----------
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING--BASIC(S).................................... 29,716 42,280
----------- -----------
----------- -----------
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING--DILUTED(S).................................. 30,280 42,844
----------- -----------
----------- -----------
</TABLE>
See the accompanying notes to the unaudited pro forma combined financial
statements.
4
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE TWELVE MONTHS ENDED MARCH 31, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
QUEST PRO FORMA
DIAGNOSTICS SBCL ADJUSTMENTS PRO FORMA
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
NET REVENUES.......................................... $ 1,472,573 $ 1,646,662 $ $ 3,119,235
COSTS AND EXPENSES
Cost of services.................................... 869,999 1,103,197 (21,323)(k) 1,951,873
Selling, general and administrative................. 488,201 429,543 (6,606)(k)
(7,195)(l)
2,621(m) 906,564
Interest expense, net............................... 31,648 47,691 7,369(n)
36,740(o) 123,448
Amortization of intangible assets................... 21,411 30,549 (5,618)(p) 46,342
Other, net.......................................... 7,045 (23,734) (2,621)(m)
20,422(q) 1,112
------------ ------------ ----------- ------------
Total........................................... 1,418,304 1,587,246 23,789 3,029,339
------------ ------------ ----------- ------------
INCOME (LOSS) BEFORE INCOME TAXES..................... 54,269 59,416 (23,789) 89,896
INCOME TAX EXPENSE (BENEFIT).......................... 26,582 33,883 (13,196)(r) 47,269
------------ ------------ ----------- ------------
NET INCOME (LOSS)..................................... $ 27,687 $ 25,533 $ (10,593) $ 42,627
------------ ------------ ----------- ------------
------------ ------------ ----------- ------------
BASIC NET INCOME PER COMMON SHARE(S).................. $ 0.93 $ 1.01
------------ ------------
------------ ------------
DILUTED NET INCOME PER COMMON SHARE(S)................ $ 0.91 $ 0.99
------------ ------------
------------ ------------
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING--BASIC(S)............................... 29,691 42,255
------------ ------------
------------ ------------
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING--DILUTED(S)............................. 30,298 42,862
------------ ------------
------------ ------------
</TABLE>
See the accompanying notes to the unaudited pro forma combined financial
statements.
5
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
QUEST PRO FORMA
DIAGNOSTICS SBCL ADJUSTMENTS PRO FORMA
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
NET REVENUES.......................................... $ 1,458,607 $ 1,579,843 $ $ 3,038,450
COSTS AND EXPENSES
Cost of services.................................... 861,044 1,043,255 (23,182)(k) 1,881,117
Selling, general and administrative................. 481,634 424,514 (7,102)(k)
(7,277)(l)
2,464(m) 894,233
Interest expense, net............................... 33,403 47,640 7,672(n)
34,950(o) 123,665
Amortization of intangible assets................... 21,697 30,270 (5,349)(p) 46,618
Other, net.......................................... 6,968 (25,911) (2,464)(m)
14,900(q) (6,507)
------------ ------------ ----------- ------------
Total........................................... 1,404,746 1,519,768 14,612 2,939,126
------------ ------------ ----------- ------------
INCOME (LOSS) BEFORE INCOME TAXES..................... 53,861 60,075 (14,612) 99,324
INCOME TAX EXPENSE (BENEFIT).......................... 26,976 34,147 (9,465)(r) 51,658
------------ ------------ ----------- ------------
NET INCOME (LOSS)..................................... $ 26,885 $ 25,928 $ (5,147) $ 47,666
------------ ------------ ----------- ------------
------------ ------------ ----------- ------------
BASIC NET INCOME PER COMMON SHARE(S).................. $ 0.90 $ 1.13
------------ ------------
------------ ------------
DILUTED NET INCOME PER COMMON SHARE(S)................ $ 0.89 $ 1.11
------------ ------------
------------ ------------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--
BASIC(S)............................................ 29,684 42,248
------------ ------------
------------ ------------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--
DILUTED(S).......................................... 30,229 42,793
------------ ------------
------------ ------------
</TABLE>
See the accompanying notes to the unaudited pro forma combined financial
statements.
6
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
BALANCE SHEET
(a) Reflects gross cash proceeds of $1,363.4 million in debt to finance the cash
purchase price and transaction costs associated with the SBCL acquisition,
to repay Quest Diagnostics' existing bank debt and to repurchase its 10 3/4%
notes. The debt is assumed to consist of $1,063.4 million of borrowings
under the new credit facility and the issuance of $300 million in new senior
subordinated notes.
(b) Reflects the reduction in gross proceeds associated with the payment of
deferred financing costs totaling $46.7 million, less amounts paid through
March 31, 1999 of $4.7 million which have been capitalized and are recorded
in the Quest Diagnostics historical balance sheet as of March 31, 1999
within other assets. The $2.7 million in financing costs related to the
capital markets loan facility, which Quest Diagnostics does not expect to
draw, were charged to common stockholders' equity, net of a tax benefit of
$1.1 million. The remaining financing costs of $39.3 million will be
capitalized.
(c) Reflects the payment of estimated costs, including premiums and related
expenses, to purchase Quest Diagnostics' existing 10 3/4% notes. These
costs, totaling $23.2 million, were charged to common stockholders' equity,
net of a tax benefit of $9.2 million. Based on market conditions at the
completion of the tender offer, the estimated costs to purchase Quest
Diagnostics' existing 10 3/4% notes may vary from that indicated above.
(d) Reflects the repayment of Quest Diagnostics' existing bank debt and the
repurchase of the 10 3/4% notes, plus accrued interest payable of $7.1
million as of March 31, 1999. The unamortized balance of deferred financing
costs related to such debt of approximately $7.7 million was charged to
common stockholders' equity, net of taxes of $3.0 million.
(e) Reflects SmithKline Beecham's sweep of remaining cash balances of SBCL as of
March 31, 1999.
7
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(f) Reflects the purchase of SmithKline Beecham's clinical laboratory business
and the preliminary allocation of purchase price to the SBCL assets and
liabilities acquired under the purchase method of accounting. The
preliminary purchase price allocation is as follows (in millions):
<TABLE>
<S> <C> <C>
Cash portion of the purchase price.................................... $ 1,005.0
Non-compete consideration............................................. 20.0
---------
TOTAL CASH CONSIDERATION BEFORE ADJUSTMENTS........................... 1,025.0
Tangible net worth adjustment to cash portion of the purchase price... (30.9)(1)
Value of shares of common stock of Quest Diagnostics issued to
SmithKline Beecham.................................................. 251.9
---------
ADJUSTED PURCHASE PRICE............................................... 1,246.0
ESTIMATED NET ASSETS ACQUIRED:
Accounts receivable, net............................................ 394.2
Other current assets................................................ 28.6
Property, plant and equipment and other assets...................... 219.8
---------
Tangible assets acquired........................................ 642.6
---------
Current liabilities................................................. (158.9)
Other liabilities................................................... (33.1)
---------
Liabilities assumed............................................. (192.0)
---------
TANGIBLE NET ASSETS ACQUIRED BEFORE PRO FORMA AND PURCHASE ACCOUNTING
ADJUSTMENTS......................................................... 450.6
PURCHASE ACCOUNTING ADJUSTMENTS:
Purchase liabilities and integration cost estimates................. (95.6 (2)
Current deferred tax assets......................................... 17.8(3)
Noncurrent deferred tax assets...................................... 16.0(3)
---------
Total purchase accounting adjustments........................... (61.8)
---------
Adjusted net assets................................................... 388.8
---------
Estimated intangible assets........................................... 857.2(4)
SBCL intangible assets recorded at March 31, 1999..................... 499.6
---------
Pro forma adjustment--intangible assets............................... $ 357.6(4)
---------
---------
</TABLE>
- ------------------------
(1) The cash purchase price provided for in the stock and asset purchase
agreement may be adjusted downward to the extent that the tangible net
worth (as defined in the stock and asset purchase agreement) of
SmithKline Beecham's clinical laboratory testing business is less than
$486 million as of the closing date. Assuming the SBCL acquisition closed
March 31, 1999, the cash portion of the purchase price would have been
reduced by $30.9 million. The tangible net worth adjustment of $30.9
million has been recorded within other current assets.
(2) Purchase liabilities include estimates for deal related costs of $10.1
million. These deal costs consist primarily of fees and expenses of
investment bankers, attorneys and accountants, printing costs, SEC filing
fees and other related charges. Through March 31, 1999, approximately
$1.1 million of these costs had been paid and were included in the Quest
8
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Diagnostics historical balance sheet as of March 31, 1999 within other
assets. The remaining estimated fees of $9.0 million are included in
accounts payable and accrued expenses in the March 31, 1999 unaudited pro
forma combined balance sheet.
Costs to realize synergies associated with the elimination of duplicate
facilities and excess capacity of SBCL are estimated at $85.5 million.
Approximately $45.0 million is primarily related to employee termination
costs and costs to exit leased facilities. The remaining $40.5 million is
attributable to write-offs of fixed assets for which management believes
there is no future economic benefit as a result of the SBCL acquisition.
These estimates may be revised as the integration plans are more fully
developed and finalized.
(3) Reflects deferred tax assets recorded as a result of the purchase
accounting adjustments recognized in connection with the SBCL
acquisition.
(4) Based on the preliminary allocation of the purchase price above, the
SBCL acquisition will result in $857.2 million of intangible assets.
Based on SBCL's historical financial statements, a pro forma adjustment
of $357.6 million was reflected in the unaudited pro forma combined
balance sheet at March 31, 1999. The decrease in common stockholders'
equity of $698.3 million represents the elimination of SBCL's remaining
net equity of $950.2 million, offset by the value of about 12.6 million
shares of Quest Diagnostics common stock issued to SmithKline Beecham of
$251.9 million.
(g) Reflects the payment of the remaining deal costs as noted in (f)(2) above at
the time of closing of the SBCL acquisition.
(h) Reflects the restructuring charge of $104.5 million (net of taxes of $41.3
million) for the estimated costs associated with the elimination of excess
capacity and duplicate facilities of Quest Diagnostics. $55.0 million
represents accrued liabilities primarily attributable to work force
reductions and the costs to exit leased facilities. The remaining $49.5
million is due to fixed asset write-offs for which management believes there
is no future economic benefit as a result of the SBCL acquisition.
These estimates may be revised as the integration plans are more fully
developed and finalized.
(i) Quest Diagnostics maintains several stock-based compensation plans. As a
result of the SBCL acquisition, certain previously issued grants of both
restricted common shares and options issued to employees will immediately
vest. The pro forma adjustment recognizes the expense associated with this
accelerated vesting of $3.5 million, net of taxes of $1.4 million.
(j) Billing for laboratory services is complicated. Laboratories must bill
various payers, such as patients, insurance companies, Medicare, Medicaid,
doctors and third parties, all of which have different billing requirements.
Among the many factors complicating billing are (1) price differences
between the fee schedules of an independent clinical laboratory and the
payer, (2) disputes between payers as to which party is responsible for
payment, (3) auditing for specific compliance issues and (4) the
inconsistent policies and regulations utilized by the over 20 local carriers
which administer Medicare. Quest Diagnostics and SBCL have taken different
approaches to managing these complexities and have employed different
policies and procedures relative to the estimation of reserves for doubtful
accounts. These underlying differences include, among other things,
procedures to obtain missing information and billing and collection cycles.
As a result of
9
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
these differences, Quest Diagnostics and SBCL have developed different
models for estimating the collectibility of receivables. Quest Diagnostics
management is quantifying the estimated impact on reserves that would result
if SBCL calculated its reserves under the Quest Diagnostics accounting
policies and methodology. The process of conforming accounting policies and
methodologies is expected to result in an increase in reserves for doubtful
accounts related to SBCL accounts receivable which is not reflected in the
unaudited pro forma combined financial statements.
STATEMENT OF OPERATIONS
(k) Reflects a net reduction in employee benefits, principally related to
retirement and post-employment benefit plans sponsored by SmithKline Beecham
which were not assumed by Quest Diagnostics under the stock and asset
agreement. Responsibility for the costs and liabilities associated with
those plans will remain with SmithKline Beecham.
(l) The pro forma adjustment reflects a reduction in expenses related to general
corporate overhead which was allocated to the historical combined financial
statements of SBCL and related affiliates by SmithKline Beecham.
(m) The pro forma adjustment reclassifies SBCL's research and development costs
on a basis consistent with that of Quest Diagnostics as selling, general and
administrative expenses as opposed to other, net.
(n) The pro forma adjustment reflects a reduction in interest income recognized
by Quest Diagnostics in the respective period. Assuming the SBCL acquisition
and anticipated borrowings under the new credit facility and the new notes
took place on the first day of such period, average cash balances during the
periods presented would have been lower, resulting in significantly lower
amounts of interest income earned on cash and cash equivalents.
(o) The pro forma adjustment to interest expense, net represents the difference
between the combined historical interest expense (consisting of the interest
incurred by Quest Diagnostics on its existing bank debt and 10 3/4% notes,
and the intercompany interest expense charged and allocated to SBCL), and
the assumed interest expense under the new credit facility and the new notes
for the periods presented. The debt is assumed to consist of $1,063.4
million of borrowings under the new credit facility and $300 million of
principal from the new notes. The assumed interest rates on these new
borrowings are 8.25% and 9.5% for the new credit facility and the notes,
respectively. If the interest rate in the new credit facility fluctuates by
1/8%, interest expense fluctuates by approximately $1.3 million annually.
Depending on market conditions at the time of the offering of new notes and
the consummation of the new credit facility, the total combined debt amount,
the interest rates, and the amounts of each of the new credit facility and
the notes may vary from that indicated above.
(p) Reflects the pro forma impact on the amortization of intangible assets
discussed in (f)(4) above. Amortization was calculated on the straight-line
basis over periods not exceeding forty years.
(q) This pro forma adjustment removes non-recurring gains on the sale of assets
recorded in SBCL's historical combined financial statements for the
respective periods. For the twelve months ended March 31, 1999, SBCL
recognized income from the sale and license of certain technology and the
sale of its physician office-based teleprinter assets and network of about
$10.6 million and $9.8 million, respectively. The sale of SBCL's physician
office-based teleprinter assets and network was
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
recognized in the first quarter of 1999. Income recognized by SBCL related
to the sale and license of certain technology during the year ended December
31, 1998 totaled about $14.9 million.
(r) The pro forma adjustment to income tax expense represents the estimated
income tax impact of the pro forma adjustments at the incremental tax rate
of 39.5%. On an annual basis, approximately $4.0 million of the pro forma
adjustment to amortization of intangible assets is deductible for tax
purposes.
(s) Basic net income per common share is calculated by dividing net income, less
preferred stock dividends, by the weighted average number of common shares
outstanding. Diluted net income per common share is calculated by dividing
net income, less preferred stock dividends, by the weighted average number
of common shares outstanding after giving effect to all potentially dilutive
common shares outstanding during the period. Potentially dilutive common
shares primarily represent outstanding stock options. Basic and diluted net
income per share on a pro forma basis gives effect to about 12.6 million
shares of Quest Diagnostics common stock issued to SmithKline Beecham,
assuming the SBCL acquisition closed on the first day of such period.
Pro forma net income for the year ended December 31, 1998 included about $11
million ($6.7 million, net of tax or $0.16 per basic and diluted share on a
pro forma basis) of non-recurring gains recorded by SBCL in 1998,
principally the result of a favorable settlement of a contract dispute. Such
non-recurring gains approximate $3 million for the twelve months ended March
31, 1999.
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